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Investment Basics

The investment of capital, whether private or institutional, entails two distinctive processes, namely the formulation of an investment policy and then the investment strategy to be followed. The former revolves around the question of what asset class selection (equities, bonds, properties and cash) to use for a chosen set of risk profiles and time horizons, while the investment strategy refers to the methods used to invest capital.

Essentially two investment strategies can be identified, namely active investing and passive investing. The former – whether done by a professional manager on behalf of investors or by an individual for him/herself – requires active and continuous decision-making about which assets to buy and sell, in order to achieve superior returns against the market average (index). This method necessitates asset selection and market timing, but comes at a price for investors; both transactional and management fees will deflate potential returns. Passive investing or index investing on the other hand, accepts the market average (index); it is not concerned with asset selection, except to minimise investment costs. This constitutes the basic difference between the two strategies: superior returns at a cost versus average returns at minimal cost.

The question arises as to which strategy is optimal or which will most effectively achieve real growth over time. Basically it boils down to whether with active investing the extent of achieving above-average returns will surpass its cost factors. Read further…